A simple General Constrained Dynamics

(GCD) model
for demand, supply and price shocks

Erhard Glötzl
Linz, Austria
erhard.gloetzl@gmail.com

February 2022

Key words: macroeconomic models, demand shock, supply shock,

price shock, constraint dynamics, GCD, DSGE, out-of-equilibrium
dynamics, Lagrangian mechanics, stock flow consistent, SFC

JEL: A12, B13, B41, B59, C02, C30, C54, C60, E10, E70
Abstract
In economics balance identities as e.g. C+K'-Y(L,K) = 0 must always apply.
Therefore, they are called constraints. This means that variables C,K,L cannot
change independently of each other. In General Equilibrium Theory (GE), the
solution for equilibrium is obtained as optimisation under the above or similar
constraints. The standard method for modelling dynamics in macroeconomics are
Dynamic Stochastic General Equilibrium (DSGE) models. Dynamics in DSGE
models result from the maximisation of an intertemporal utility function that
results in the Euler-Lagrange equations. The Euler-Lagrange equations are
differential equations that determine the dynamics of the system. In Glötzl, Glötzl,
und Richters (2019) we have introduced an alternative method to model
dynamics, which is constitutes a natural extension of GE theory. It is based on the
standard method for modelling dynamics under constraints in physics. We
therefore call models of this type "General Constrained Dynamic (GCD)" models.
GCD models can be seen as an alternative to DSGE models to model the dynamics
of economic processes. DSGE models are used in particular to analyse economic
shocks. For this reason, the aim of this article is to show how GCD models are
formulated and how they can be used to model economic shocks such as demand,
supply, and price shocks. Since the goal of this paper is to lay out the fundamental
principles to the formulation of such GCD models, very simple macroeconomic
models are used for illustrative purposes. All calculations can easily be carried
out with the open-source program GCDconfigurator, which also allows for the
integration of shocks.
 Contents
Abstract.................................................................................................................. 2
Contents ................................................................................................................. 3
1. Introduction ..................................................................................................... 4
2. GCD models for non-intertemporal utility functions ..................................... 7
3. Modeling of supply, demand and price shocks............................................. 10
3.1. 2 different types of shocks ...................................................................... 10
3.2. Examples of demand shocks................................................................... 10
3.3. Examples of supply shocks ..................................................................... 11
3.4. Price shock .............................................................................................. 12
3.5. Policy shocks .......................................................................................... 13
4. Topics to be discussed................................................................................... 13
5. Model A1, (1 household, 1 firm, 1 good, without interest) .......................... 15
5.1. Overview of the setup ............................................................................. 15
5.2. Description of the A1 model in detail .................................................... 16
6. Calculations with model A1 on various shocks ............................................ 21
7. Calculations with model B1 for central bank polices in case of inflation and
deflation shock .................................................................................................... 29
7.1. Overview of the setup of model B1 ........................................................ 29
7.2. Inflation and deflation shock as variable shock for the price ................. 31
7.3. Model inflation and deflation shock as model shock ............................. 34
8. Summary ....................................................................................................... 35
Acknowledgements ............................................................................................. 35
References ........................................................................................................... 36
1. Introduction

The standard method in macroeconomics for modelling dynamics is DSGE

(Dynamic Stochastic General Equilibrium). Dynamics in DSGE models are
generated by maximising an intertemporal utility function, which leads to the
Euler-Lagrange equations. The Euler-Lagrange equations are differential
equations which the dynamics must satisfy.

Recently there has been a renewed interest in alternative approaches in

macroeconomics. In Zaman (2020) four different methodological principles are
presented which lie outside the framework of the conventional approach. One of
these concepts is called GCD (General Constrained Dynamics) and is based on
the standard method of physics for modelling a dynamic under constraints. It
can be seen as a natural extension of the GE theory for modelling dynamics in
economics and can be thought of as an alternative to DSGE. The method was
first introduced in Glötzl (2015) under the name Newtonian Constrained
Dynamics, a name that was later changed to General Constrained Dynamics.
The principles of GCD, an encompassing review of the literature and an
application of GCD to the microeconomic Edgeworth box model are presented
in Glötzl, Glötzl, und Richters (2019). In Richters und Glötzl (2020) it is shown
that SFC models (stock flow consistent models (Godley und Lavoie 2012)) can
be understood as special forms of GCD models. In Richters (2021) a more
complex macroeconomic model is used to show that GCD models converge to
the classical equilibrium solution under some assumptions. In Glötzl (2022c) we
show how macroeconomic GCD models can be built in a systematic way and
how they can be used for macroeconomic analysis. In this respect, we want to
point out that all calculations for all GCD models with non-intertemporal utility
functions can be performed easily and conveniently with the open source
program GCDconfigurator, which is published in GitHub (Glötzl und Binter
2022) which can be downloaded under

https://github.com/lbinter/gcd

All Mathematica program codes used for calculations of the various GCD
models can be downloaded under

https://www.dropbox.com/sh/npis47xjqkecggv/AAAMzCVhmhDYIIhoB5MfA
TFya?dl=
DSGE models are typically used to analyse economic shocks. The target of this
article is to show how any kind of economic shock, e.g. demand, supply or price
shocks, can be modelled in the GCD framework. In this paper we limit ourselves
to GCD models with non-intertemporal utility functions.

In contrast to DSGE models, all previously published GCD models were based
on non-intertemporal utility functions. Since intertemporal utility functions are
essential in many applications and only intertemporal utility functions are used in
DSGE models, (Glötzl 2022a) describes the principles of formulating
intertemporal GCD models (IGCD) and shows that these IGCD models can be
seen as a generalisation of and alternative to DSGE models. Also in such GCD
models with intertemporal utility functions shocks can be integrated in the same
way as shown in the following for GCD models with non-intertemporal utility
functions.

Non-intertemporal GCD models and intertemporal GCD models can be

considered as an essential contribution to solve problem 8 of the 18 major
problems of dynamics listed by Steve Smale in 1991 (Smale 1991; 1997; 1998;
Smale Institute 2003)

In chapter 2 we give a brief introduction the GCD method for non-intertemporal

utility functions.

In chapter 3 we describe the different types of economic shocks and how they can
be modelled.

In chapter 4 we discuss the possible model applications related to economic

shocks.

In chapter 5 we describe the simple macroeconomic model A1, into which we

then integrate supply, demand and price shocks in chapter 6.

In chapter 6 we show the results of the numerical calculations of the impact of

various shocks introduced into the A1 model.

In chapter 7 we describe the model B1, which includes a commercial bank and a
central bank to describe money creation. We present numerical calculations for
the impact of inflation and deflation shocks.

In chapter 8 we give a summary.

2. GCD models for non-intertemporal utility
functions

In general, a dynamic economic model is described by agents and variables that

describe any stock or flow of goods, resources, financial liabilities or other
variables or parameters such as prices or interest rates. The behaviour of these
variables is described by behavioural equations. The behaviour of these variables
can be restricted by economic constraints, which are described by additional
equations. In particular, all balance sheet identities are subject to such constraints.
In general, the introduction of additional constraints to the behavioural equations
can lead to the system of equations becoming overdetermined and thus
unsolvable. The GCD method is a "closure" method to make a system of equations
solvable by introducing additional Lagrange multipliers. It can also be understood
as a method to transfer the concept of Lagrange multipliers from optimization
problems under constraints to dynamic systems under constraints. This is done in
analogy to what is done in classical mechanics.

The GCD method is described in detail in Glötzl, Glötzl, und Richters (2019). We
will therefore limit ourselves to the explanation of a simple example with 2 agents
(each with 1 non-intertemporal utility function) and 1 constraint.

We explain the principle for 2 agents A, B and 2 variables x1 , x2 .

The utility functions of A, B are U A ( x1 , x2 ), U B ( x1 , x2 ) . The interest of A is to change
x1 , x2 so that the increase of his utility function is maximal. This is given, if the
change of x1 , x2 is done in the direction of the gradient of U A ( x1 , x2 ) , i.e.
 U A 
 x   
 x1 
  proportional to
1

x   U A 
 2   
 x2 
The interest of A in a change of the variables does not lead alone to an actual
change, because the household must have also the power and/or possibility of
actually implementing its change desire. For example, a household cannot or can
only partially enforce its additional consumption desire, e.g., to go to the cinema
or go on vacation, because it is possibly quarantined or the borders are closed.
This limitation of the possibility to enforce his consumption change requests is
described by a (possibly time-dependent and endogenously determined) "power
factor" CH . In general, the change request for each of the variables is described by
"power factors"  xH ,  xH . Considering the power factors, the following applies to
1 2

the change of x1 , x2 (due to the interest of A and the power of A to enforce this
interest)

 A U A 
 x    x1 
x1 
  proportional to 
1

x   U A 
 2    xA2 
 x2 

Just as A has an interest, to change x1 , x2 , also B has an interest to change these

two variables. The actual change is therefore the result of the two individual
efforts to change, weighted with the power factors. We therefore call this
behaviour "individual utility optimization".

 A U A   B U B 

 x    x1 x   x1
 
 1   x1 
 =
1
+ <2.1>
 x    A U A   B U B 
 2   x
 2 x    x2 
x2 
 2  

This equation of motion <2.1> describe the temporal development of ( x1 , x2 ) under

the condition that there are no constraints that restrict the temporal development.
It is therefore referred to as the ex-ante equation of motion.

If a constraint

Z ( x1 , x2 ) = 0

exists, there arises an additional constraint force f Z to the ex-ante force which
ensures that the constraint is fulfilled at all times. In physics, this constraint force
is perpendicular to the constraint at all times due to the so-called d'Alembert
principle, i.e.

 Z ( x1 , x2 ) 
 f ( x1 , x2 ) 
Z  x1 
f Z ( x1 , x2 ) =  1
 =    <2.2>
1
Z
 f ( x1 , x2 )    Z ( x1 , x2 ) 
 
 x2 
The time-dependent factor  =  (t ) is called Lagrange multiplier, as in the case of
optimisation under constraints.

In economic models, the constraint force does not necessarily have to be

perpendicular to the constraint at any point in time due to a special economic
principle as in physics, but in most cases it is plausible to model constraint forces
in a similar way to physics, namely perpendicular to the constraint.

From <2.1> and <2.2> we get the equation of motion, which is called ex post
equation of motion:

 A U A ( x1 , x2 )   B U B ( x1 , x2 )   Z ( x1 , x2 ) 
 x         
x1 x1 x1
x1 x1

 1 = +  +   <2.3>

 x    A U A ( x1 , x2 )   B U B ( x1 , x2 )   Z ( x1 , x2 ) 
 2   x    x2   
 2 x2 x2 x2
     

For J agents with the designations j = 1, 2,..., J

I Variables with the designations xi i = 1,2,..., I x = ( x1, x2 ,..., xI )
K Constraints with the designations Zk k = 1,2,..., K
the general GCD model equations result analogously

J
U j ( x) K Z k ( x)
xi =   xji +  k i = 1,2,..., I <2.4>
j =1 xi k =1 xi

Remark: If constraint conditions depend on time derivatives of variables

If a constraint depends not only on x = ( x1, x2 ,....xI ) but also on x = ( x1, x2 ,....xI ) or
higher derivatives x = ( x1, x2,....xI ), ..... ,i.e.
0 = Z ( x, x, x,....)
the constraint forces are always to be derived from the highest time derivative of
the variables (Flannery 2011), i.e.

Z ( x, x) Z ( x, x) Z ( x, x, x) Z ( x, x, x)

instead of resp. instead of
xi xi xi xi
3. Modeling of supply, demand and price shocks

3.1. 2 different types of shocks

Basically, a shock can lead to 2 fundamentally different types of shocks:

(1) Variable shock

All model parameters remain unchanged, but at the time of the shock ts one or
more model variables V  {C, L, K , M H , M F , S , p, w} abruptly change by the factor fV
from V to fV V
V (ts ) → fV V (ts )
Interpretation: The basic behaviour of all agents remains the same, but an external
event suddenly changes the value of a variable (e.g. the price of energy). The
system restarts, as it were, with this new value as the starting value.

(2) Model shock

All variables remain unchanged, but one or more model parameters or power
factors   { ,  ,  , CH ,  LH ,  LF ,  KF ,  MH ,  SF ,  pF ,  wF } are no longer constant but change
H

over time, i.e.  →  (t ) . For the sake of simplicity, we describe the temporal
behaviour of such a parameter  (t ) by multiplication with a sawtooth curve:
 (t ) =   (t )
where the sawtooth curve is defined by

ts time of the shock

f shock factor
d duration of the linearly decreasing shock effects

1 for t  t s
f for t = t s

 (t ) = 
 linear from f to 1 for t s  t  t s + d
1 for t s + d i j  t

3.2. Examples of demand shocks

For example, a demand shock N can have three different causes:

(1) Variable shock: A demand shock can be triggered by the fact that at the time
of the demand shock t N consumption C is reduced by a factor fCN from C to
f CN C :

C → fCN C
At the same time, the constraint Z3 must always be fulfilled, even during
the shock. This is always guaranteed by the numerical solution method for
differential-algebraic equations of Mathematica NDSolve. In addition, of
course, one can make any other assumptions, such as that production Y and
investment K  remain the same and that everything that is consumed less
(1 − f NC )C (t N ) is stored, i.e.
S (t A ) → S (t A ) + (1 − gCN )C (t A )
The dynamic system then continues to develop with these new initial
values.

(2) Model shock: The model parameter  describes the consumption

preference of the household. A demand shock can be triggered by the
changes of  over time according to a sawtooth curve:

 →  (t ) =  (t ) 

(3) Model shock: The power factor CH describes the power of the household
to actually enforce its consumption interests (e.g. due to quarantine
measures). A demand shock can be triggered by a change of CH in time
according to a sawtooth curve:
CH → CH (t ) =  (t ) CH

3.3. Examples of supply shocks

For example, a supply shock A at the time can have the following causes:

(1) Model and variable shock: A supply shock could be triggered by the fact
that the production function
Y ( L, K ) =  L K 1−
changes over time according to a sawtooth curve with a shock factor f A .
This initially corresponds to a model shock, because this is described by the
 fact that the parameter  changes according to a sawtooth curve with a
shock factor f A :
 →  (t ) =  (t ) 
At the same time, production Y suddenly changes by the shock factor f A at
the time of the shock t A :
Y (t A ) → f A Y (t A )
Because of the constraint
Z3 = 0 = Y ( L, K ) − C − K '− S '
at the time t A , therefore, C , K , S  must also change so that the constraint is
fulfilled. This leads to sudden changes in at least one of the variables or in
all of them. This is always guaranteed by NDSolve. For example, one can
also make additional more precise assumptions about the behaviour of the
other variables, e.g. one could assume that at the time t A also C , K , S 
change by the shock factor f A , i.e.
C (t A ) → f A C (t A ), K (t A ) → f A K (t A ), S (t A ) → f A S (t A )
and that the dynamic system can then adapt to these new starting conditions
and the time-varying parameter
 (t ) =  A (t ) 

(2) Model shock: The model parameter  describes the labour intensity of
production. A supply shock can be triggered by the changes of  over time
according to a sawtooth curve
 →  (t ) =  (t ) 
(3) Model shock: The power factor  KF describes the power of the firm to
actually enforce its investment interests (e.g. because of administrative
regulations). A supply shock can be triggered by the fact that the power
factor  KF changes over time according to a sawtooth curve:

 KF →  KF (t ) =  (t )  KF

3.4. Price shock

For example, a price shock P can be modelled by changing the price p at the time
t P by the factor f pP
p (t P ) → f pP p (t P )
This corresponds to a variable shock.
 3.5. Policy shocks

In addition, a wide variety of fiscal and monetary policy measures that apply from
certain time points can of course also be interpreted as economic policy shocks
and modelled in the same way, e.g:
- government measures:
o Tax reform
o Increase or decrease in public debt
o etc.
- Changes in central bank policy:
o From money supply control to interest rate control
o Change in the inflation target
o Purchase programmes
o etc.

4. Topics to be discussed

In the economy, a shock can occur for a number of reasons, e.g.

- sudden changes in raw material prices
- sudden changes in consumer behaviour due to quarantine regulations
- sudden production restrictions due to a disruption in the supply chain
- etc.

From an economic point of view, there are 2 fundamental topics related to shocks:
(1) Forecasting: How will the economic variables change?
(2) Evaluating countermeasures: What measures can be taken to overcome the
shock as quickly as possible or with as little effort as possible?
Possible measures are, for example:
- Various forms of financial assistance from the government to firms
- Various forms of financial benefits to consumers
- Different ways of financing additional government expenditure
- short-time working models
- Central bank monetary policy measures
- Organisational measures, e.g. relieving companies of administrative
regulations, extending opening hours in the retail sector, etc. Such
 organisational measures are expressed in the models by changes in power
factors or other parameters.

The target of section C. is to show that GCD models are basically suitable for
answering these 2 questions and that this can be done very easily and conveniently
with the help of the open-source program GCDconfigurator. The additions
necessary to incorporate shocks into a model programmed with GCDconfigurator
are very easy to program.

In order to apply GCD models to real economic situations, they would of course
have to be extended accordingly and adapted to the real conditions.

Using model A1 as an example, we show how special supply, demand and price
shocks can be modelled and what effects they have on the further course of the
economy.
Using model B1, we show how central bank measures have different effects on a
price shock depending on whether the central bank pursues a monetary policy or
an interest rate policy.
In order to make the effects clearly visible, the model calculations are carried out
for very strong shocks of a magnitude that is unlikely to occur in reality.
5. Model A1, (1 household, 1 firm, 1 good, without
interest)

5.1. Overview of the setup

With the aid of the GCDconfigurator programme, the differential-algebraic

equation system of the A1 model is calculated as follows:
 5.2. Description of the A1 model in detail
The one good serves as both a consumption good and an investment good. We
assume that vertical constraint forces occur.
Since the target is first to show the principle, we choose the production function
and the utility functions as simple as possible.
We choose a simple Cobb-Douglas production function as the production
function, and the goods excreted per year (depreciation) are proportional to the
capital stock. This results in the 2 necessary algebraically defined variables. They
are necessary because they occur in the utility functions or constraints.
Y ( L, K ) =  L K 1−   0, 0    1
<5.1>
DP ( K ) = dp K 0  dp  1

In addition, one can be interested, for example, in net investment, for which one
defines as a further algebraically defined variable
inv ( K ) = K ' <5.2>
Households want to consume with decreasing marginal utility. Consumption of
consumer goods C leads to a utility for households in the amount of C  with
0    1 . They strive for a desired working time L̂ . Deviations from the desired
working time L̂ lead to a reduction of utility by ( L − Lˆ ) 2 . In addition, households
aim to keep cash in the amount of Mˆ H . Deviations from the desired cash position
Mˆ H lead to a reduction in utility by ( Mˆ H − M H ) 2 . This leads to the utility function
for the household
U H = C  − ( Lˆ − L) 2 − ( Mˆ H − M H ) 2 0  1 <5.3>
For the company, in the simplest case, the utility initially consists of the goods
produced, which are valued at the selling price, i.e. pY . The produced goods are
used for:
C Sales = Consumption
S  change in inventory
K  changes in productive capital stock
In principle, it would be possible to weight the utility of these uses differently.
For the sake of simplicity, we will refrain from doing so. Therefore, this utility is
reduced by the cost of labor and the cost of storage, which we evaluate through
the deviations from the planned inventory. For simplicity, we assume that holding
money in cash has no influence on the utility. This leads to the utility function
for the firm
U F = pY ( L, K ) − w L − ( Sˆ − S ) 2 = p L K 1− − w L − (Sˆ − S ) 2 <5.4>
From the model graph, it can be seen that the following constraints must be
satisfied:
Z1 = 0 = w L − p C − M H ' for money of household H
Z2 = 0 = p C − w L − M F ' for money of firm F <5.5>
Z 3 = 0 = Y ( L, K ) − C − K '− S ' for good 1 of firm F
According to the methodology of GCD models, the interest or desire of
households to change consumption is the greater the more the utility changes
U H
when consumption changes, i.e., the interest is proportional to . However,
C
the interest in changing consumption does not in itself lead to an actual change in
consumption, because the household must also have the power or opportunity to
actually implement its desire to change consumption. For example, a household
cannot or can only partially enforce its additional consumption wish, e.g., to go to
the cinema or on holiday, because it is in quarantine or the borders are closed.
This restriction of the possibility to enforce his or her consumption change wishes
is described by a (possibly time-dependent) "power factor" CH . Analogously, the
U F
firm could have an interest and power CF to influence consumption. In the
C
U F
specific case = 0 . This results in the following behavioural equation for the
C
ex-ante planned change in consumption
U H U F
C ' = CH + CF = CH  C  −1
C C
<5.6>
The same considerations apply to labour L as to consumption. Even the
household's wish to increase or reduce working time does not in itself lead to an
actual change in working time, because the household must also have the power
or possibility to actually implement its wish to change. For example, a household
might not be able to enforce its wish to increase working time, or only partially,
because it is on short-time working or unemployed, or it might not be able to
enforce its wish to reduce working time because it is contractually obliged to work
overtime. This restriction of the possibility to enforce his wishes for a change in
working time is also described by a (possibly time-dependent) power factor,
which we denote with  LH . The same applies to the firm's ability to influence
working time.
Therefore, the behavioural equation for the ex-ante planned change in working
time is as follows

U H F U
F
L' =  H
+ L = 2 LH ( Lˆ − L) +  LF ( p  L −1K 1− − w )
L L
L

The ex-ante behavioural equations for the other variables result analogously.
However, the plans of the 2 agents household and firm to change consumption C,
labour L and the other variables cannot be enforced independently of each other,
because the constraints
Z1 = 0 = w L − p C − M H ' für Geld von Haushalt H
Z2 = 0 = p C − w L − M ' F
für Geld von Firma F <5.7>
Z 3 = 0 = Y ( L, K ) − C − K '− S ' − DP für Gut 1 von Firma F
lead to constraint forces, which we assume are vertical constraint forces. The
constraint force for the change in consumption therefore results in
Z1 Z Z
1 + 2 2 + 3 3 = − 1 p + 2 p − 3
C C C
The behavioural equation for the actual ex-post change in consumption is
therefore
U H Z Z Z
C ' = CH + 1 1 + 2 2 + 3 3 = CH  C  −1 − 1 p + 2 p − 3 <5.8>
C C C C
Analogously, the actual ex-post change in labour is as follows
U H U F Z Z Z
L ' =  LH +  LF + 1 1 + 2 2 + 3 3 =
L L L L L
H ˆ
= 2  L ( L − L) +  L ( p  L K − w ) + 1w − 2 w + 3 L −1K 1−
F  −1 1−

This also applies analogously to the company's investments. In the case of the
company, too, the actual implementation of ex-ante planned investment increases
can be prevented by real restrictions, e.g. by interruptions in supply chains. In the
same way, a desired reduction in investment may not be possible to the desired
extent because the project is a large-scale project of many years' duration. These
restrictions can in turn be described by a (possibly time-dependent) power factor
 KB . This results in the following behavioural equation for the actual ex-post
change in capital
U F Z Z Z
K ' =  KF + 1 1 + 2 2 + 3 3 =  KF p (1 −  ) L K − − 3 <5.9>
K K K K '
Z Z
Note that we have to use 3 instead of 3 because the constraint forces are
K ' K
always derived from the highest time derivative of the variables (see Remark in
chapter 2 (Flannery 2011).
The equations of behaviour for M H , M F , S , p, w are derived analogously. In sum,
this results in the model equations
differentiell behavioural equations
U H U F Z Z Z
C ' = CH + CF + 1 1 + 2 2 + 3 3 =
C C C C C
 −1
= C  C − 1 p + 2 p − 3
H

U H U F Z Z Z
L ' =  LH +  LF + 1 1 + 2 2 + 3 3 =
L L L L L
H ˆ  −1 1−
=  L ( L − L) + 1w − 2 w + 3 L K
U H U F Z Z Z
K ' =  KH +  KF + 1 1 + 2 2 + 3 3 =
K K K K K '
 −
=  K p  (1 −  ) L K − 3
F

U H U F Z1 Z 2 Z 3
M H ' =  MH H +  F
+ 1 + 2 + 3 =
M H MH
M H
M '
H
M H
M H
(
= 2  H H Mˆ H − M H −  H
M )
U U F
H
H Z
H
B Z
B
Z1
M '=
F H
+ M F
F
+ + + 1 =
MF
M F
M F
M '
F
M F
M F
= −2
U H U F Z Z Z
S ' =  SH +  SF + 1 1 + 2 2 + 3 3 =
S S S S S '
(
=  F Sˆ − S − 
S ) 3

U H
U Z Z
F
Z
p ' =  pH +  pF + 1 1 + 2 2 + 3 3 =
p p p p p
=  pF  K 1− L − 1c + 2c
U H U F Z Z Z
w ' =  wH +  wF + 1 1 + 2 2 + 3 3 =
w w w w w
= −  w L + 1L − 2 L
F

Or written in a clearer way

differentiell behavioural equat ions
C ' = CH  C  −1 − 1 p + 2 p − 3
L ' = 2  LH ( Lˆ − L) +  LF ( K 1− L−1+ p − w ) + 1w − 2 w + 3 K 1− L−1+
K ' =  KF  (1 −  ) L K − p − 3

(
M H ' = 2  MH H Mˆ H − M H − 1 )
M F ' = −2

(
S ' =  SF Sˆ − S − 3 )
p ' =  pF  K 1− L − 1c + 2c
w ' = −  wF L + 1L − 2 L
6. Calculations with model A1 on various shocks

We model the following shocks

https://www.dropbox.com/s/cdewtdh2zrwfrfp/Modell%20A1%20SCHOCK%20
Version%2024.nb?dl=0

With no shocks
With multiple shocks
Price shock at t = 20, p→2p
Demand shock due to variable shock (consumption shock)
at t = 15 C → 0.5 C
Demand shock due to model shock (shock to power of households)
at t = 10 CH → 0.5CH thereafter, the power of the households increases again
linearly to CH within the time period dn = 5
Supply shock due to model shock (shock to power of the firm)
at t = 10  KF → 0.5 KF thereafter, the power of the firm increases again linearly
to  KF within the time period da = 5

Supply shock due to model shock (technology jump)

at t = 10  → 1.5 i.e. a technological jump occurs, the resulting increase in
productivity is maintained permanently
7. Calculations with model B1 for central bank polices
in case of inflation and deflation shock

7.1. Overview of the setup of model B1

The target of model B1 is to model the money creation process by the central bank
in a simplified way.
In model B1, the central bank is seen as an endogenous money creator and the
bank is seen as an endogenous credit creator. The central bank's target is to keep
p
inflation at the target inflation pˆ = 0.02 i.e. 2% by means of interest rate policy
p
(  = 1 ) and monetary-supply policy(  = 0 ).
In this model B1, the central bank's interest rate policy is still modeled in a very
simplified way. We assume that the policy rate is constant 0 (banks do not pay
interest to the central bank) and that the central bank can, however, influence the
interest rate directly. That the policy rate is constant 0 is possible and does not
cause the bank to borrow arbitrarily from the central bank, since the bank is
assumed to have a constant 0 utility function. This means that the bank has no
particular interest in lending to firms or receiving savings deposits from
households. Thus, the bank lends endogenously and accepts savings deposits
endogenously.

In (Glötzl 2022b) we present more realistic models, in which shocks can be

integrated in the same way as in model B1: In model B2, we model the behaviour
of the central bank according to the Taylor rule. All these simplifying restrictions
regarding money creation hold also for models C1, C2, because in models C1, C2
we are concerned with modeling the government. It is only in the much more
comprehensive model D2 that the restrictions on the modeling of money creation
and the modeling of the government are largely abandoned.
Pay attention when establishing the constraints:
(1) Claims A have a positive sign, liabilities D have a negative sign
(2) Banks' equity capital is 0. They do not make profits.
 7.2. Inflation and deflation shock as variable shock for
the price

The simplest way to model an inflation respectively deflation shock is to model it

as a variable shock for the price as shown in chapter 5.
For example, we use:
inflation shock: p → 1.5 p
deflation shock: p → 0.5 p
at time t = 20 , because by this time the system has already settled in.

https://www.dropbox.com/s/th868lbth9ahz9i/Modell%20B1%20SCHOCK%20
Version%203.ndsolve.nb?dl=0

Certainly, one could also interpret these calculations in economic terms. But
without prior adjustment of the models to real conditions, a real interpretation is
not really serious. Therefore, we will not comment further on the calculated
graphs.
As emphasized several times, the target of this book is to present the methodology
of the GCD models in principle and to give an idea of what can be done with them
and in what form. For application to concrete economic questions, the GCD
models still need to be adapted to real conditions. This is one of the tasks that still
has to be done in the future.
Model B1 without shock
Inflation shock p → 1.5 p , pure money supply policy of central bank  = 0

Inflation shock p → 1.5 p , pure interest policy of central bank  = 1

deflation shock p → 0.5 p , pure money supply policy of central bank  = 0

deflation shock p → 0.5 p , pure interest policy of central bank  = 1

7.3. Model inflation and deflation shock as model

shock

Another possibility to model an inflation or deflation shock would be:

Introduce an agent A who has some power  psA to influence the price change
ps = p . (Consider e.g. OPEC as agent, which has the intention and the power to
influence the trend in oil prices). If A intends to increase the price p at time t0
for 1 year this leads to an inflation or deflation shock which can be modeled in
the following way:
U A = −( ps − ps ) 2
 psA (t ) = 0 for t   0, t0  and t  t0 + 1
 psA (t ) = 1 for t  t0 , t0 + 1
We give this as an example, but do not calculate this model in detail.
Obviously, there are a lot of other possibilities to model price respectively
inflation or deflation shocks.

8. Summary
GCD models are a natural extension of GE theory. They are based on the standard
method for modelling dynamics under constraints in physics and can be thought
of as an alternative to DSGE models. DSGE models are typically used to analyse
economic shocks. For this reason, the aim of this article was to show how any
kind of economic shock, e.g. demand, supply or price shocks, can be modelled
within the framework of GCD models.

Acknowledgements
My thanks go above all to my son Florentin, who has advised me on all economic
matters over the years, and especially to Oliver Richters, who has been a faithful
companion in all matters of economics and physics for many years and without
whom many of the publications would not have been possible.
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